STRENGTHS

WEAKNESSES

Dependent on the agricultural sector and a handful of trading partners, notably Brazil and Argentina

Weak governance (corruption and patronage)

Large informal market (40% of GDP)

RISK ASSESSMENT

Strong growth driven by domestic demand

Growth will remain resilient in 2019, driven by strong domestic demand. Maquilas (factories built for foreign companies under the free zone regime) will continue to grow rapidly owing to sharply rising private investment, mainly in the assembly of automotive parts (50% of maquila exports) and textiles (32% of the total including shoes). Vibrant performances by the maquilas, thanks to an attractive tax policy for foreign investors, will support job creation and ultimately household purchasing power. Private consumption will be driven by the 3.5% increase in the minimum wage that came into effect in July 2018. Inflation is expected to remain in the middle of the target range (2-6%) set by the central bank, which will therefore keep its monetary policy unchanged, assuming there is no shock to the guarani. The banking system remains fragile, as it is highly dollarised (47% of loans and 45% of deposits in August 2018) and reliant on the agricultural sector, which accounts for a large proportion of the loans granted.

Exports will benefit from the relatively improved economic situation in Brazil and Argentina, the country's main trading partners, after the tougher economic times of 2018. The agri-food sector, which is export-oriented, should therefore continue to expand vigorously. However, external trade is expected to contribute negatively to growth once again, due to strong import growth following the increase in domestic demand.

Prudent fiscal policy and small current account deficit financed by FDI

The government will continue its prudent fiscal policy in 2019 and should keep to the deficit limit of 1.5% of GDP set in the Fiscal Responsibility Act. Strong economic activity will continue to support tax revenues, which will also be lifted by a hike in tobacco taxation. Revenues should therefore offset the increase in public spending, particularly in health and education, and allow the government to maintain a small primary surplus. The share of the public sector in the economy is one of the lowest in the region, with revenues representing less than 20% of GDP due to the very narrow tax base. Public debt, the lowest in Latin America, will remain measured and will be financed on international markets, with a USD 600 million bond issue planned in the 2019 budget.

The relative improvement in the economic situation of the country’s main partners should support agricultural exports, mainly from the soya (40% of the total) and meat (15%) sectors, and electricity exports (23%) from the bi-national hydroelectric power plants of Itaipú (Brazil) and Yacyretá (Argentina). The trade surplus will be moderated by strong import growth, due to lively household consumption and investment. However, given the nature of the products exported, the size of this surplus will depend on weather conditions. The income balance, which is structurally in deficit because of dividend repatriation, is only partially offset by remittances from expatriates. The resulting small current account deficit will be financed by the net inflow of FDI (1.2% of GDP in 2017) into agricultural sectors, construction and, more broadly, the maquilas. While capital from the United States and Spain remains significant, recent years have seen a surge in FDI from Brazil. With these net capital inflows complemented by the abovementioned bond issue, foreign exchange reserves will remain comfortable (they stood at seven months of imports in the first half 2018).

New President, same policies

The April 2018 general elections were won, unsurprisingly, by Mario Abdo Benítez of the Colorado Party. Former Senate President and son of the private secretary of dictator Alfredo Stroessner (1954/89), Mr Abdo Benítez succeeded Horacio Cartes, also of the Colorado Party. As such, although Mr Abdo Benítez represents the most conservative wing of the party, the social and economic policies put in place are likely to be in line with those of his predecessor. His campaign promises contained proposals to keep pro-business measures, including low taxes to stimulate foreign investment (Maquila Law, in place since 2000). At the same time, given the limited fiscal resources available, social spending will be restricted and is unlikely to enable much progress in the fight against poverty. In addition, because the Colorado Party lacks an absolute majority in the Senate (17 seats out of 45), and owing to divisions between the conservative wing of Mr Abdo Benítez (Colorado Añetete) and the more moderate wing of his predecessor (Honor Colorado), the government is being forced to seek alliances. The President has therefore begun a dialogue with opposition parties with a view to reforming the justice system and the electoral law – changes that will nonetheless be difficult to implement.

The business environment remains weak, with the country placing 103rd out of 190 in the World Bank's Doing Business 2018ranking, mainly due to the large informal economy and corruption, and 135th out of 180 in Transparency International’s Corruption Perceptions index.